1. Overview   How did the financial crisis affect us?   What are some likely hypotheses regarding the causes of the financial collapse?   What do today's banks do? Hint: Do they still follow the 3-6-3 rule?   Ideas for teaching about the financial crisis   Questions

2. How did the financial crisis affect us?

3. Average Real Disposable Income Was Rising

4. Savings Rates Were Falling

5. Household Debt to Disposable Personal Income Ratio Increases

6. Subprime, Alt-A, and Home Equity Loans Increase

7. Fall in Housing Prices

8. DJIA, S&P and Nasdaq Trends: Stock Wealth Evaporates

9. Default Rates Rise

10. Foreclosure Rates Increase

11. Recession

12. Unemployment

13. What are some likely hypotheses regarding the causes of the financial collapse?

14. What Happened?  In1989 Berlin wall falls.  China and India deregulate.  Expanded production capacity puts damper on inflation. Central banks now can increase money supply without much concern about inflation.

15. What Happened?  In 2001, the Fed consistently lowered interest rate from 6.5% to 1.75 % and to 1.0 % by June 2003.  In 2001, the Fed consistently lowered interest rate from 6.5% to 1.75 % and to 1.0 % by June 2003.  Central banks around the world followed suit creating an unprecedented increase in the supply of credit.

16. What Happened?  The low rates made borrowed money cheap and households and businesses responded as expected: they bought and bought.  In the housing market, the Case-Shiller home price index increased 80% from January 2001 to December 2005.

17. What Happened?  Federal government aggressively promotes home ownership  Homeownership rate increased from normal 64 percent (which was the rate for 35 years) to 69 percent in 2004  Subprime loans totaled $330 billion in 2001  By 2004 they reached $1.1 trillion (37% of residential mortgages)  By 2006 they were 48% of all mortgages.

18. What Happened?  In mid-2004, the Fed reversed its interest policy -- the rate climbed to 2.25 % by December 2004 and reached 5.25% in 2006.  The demand for houses and other durable goods decreased and prices declined 33% from a peak in July 2006.

19. Interest Rates and Lagged Housing Prices Housing prices Interest rates

20. Housing Bubble – Jan 92 to July 09 source: S&P Case-Schiller National Home Price Index 1987-2008 - inflation adjusted

21. Leverage The magnitude of the current financial crisis has grown because of the amount of leverage used.

22. Leverage and Incentives  Investment banks were leveraged by a ratio of 30 to 1, government sponsored mortgage giants Freddie and Fannie were closer to 50 to 1.  When asset prices are rising, this system works like a dream.

23. What do today’s banks do?

24. Period Non interest income as a % of net operating income (Banks with total assets under $1 billion) Non interest income as a % of net operating income (Banks with total assets over $1 billion) 199120.07%35.16% 199219.39%34.82% 199320.58%36.59% 199420.57%35.78% 199520.91%36.65% 199622.22%37.85% 199723.73%38.43% 199825.59%41.47% 199926.26%44.01% 200025.59%44.30% 200126.23%42.89% 200226.19%42.30% 200328.30%44.04%

27. Teaching about the financial crisis

28.   Open Market Operations   Discount Policy   Reserve Requirements   Interest on Required Reserve Balances and Excess Balances   Term Auction Facility   Primary Dealer Credit Facility   Term Securities Lending Facility   ABCP MMMF Liquidity Facility   Commercial Paper Funding Facility   Money Market Investor Funding Facility   Term Asset-Backed Securities Loan Facility

29. Questions